This "Tombstones" case focuses on several security offerings submitted by various US companies, after the financial recession in 2008 to 2009.
Timothy A. Luehrman and David Lane
Harvard Business Review (211063-PDF-ENG)
January 18, 2010
Case questions answered:
- MSFT Notes:
a. Why is MSFT raising money?
b. Is this paper really cheap? What is YTM for each issue?
c. Why YTM differs from coupon rate? What should we compare YTM with?
d. Why did MSFT issue four papers instead of one?
e. Do you expect that those notes will be called or redeemed?
- Coca Cola Enterprise Notes:
a. What is YTM for the CCE issue?
b. What are the differences w.r.t. MSFT note above?
c. What is the default risk for CCE notes?
d. Why is CCE raising funds?
- Norfolk Southern Century Bond:
a. Why did NSC “reopen” this issue to raise another $250M?
b. Do you think NSC is going to be around in 2105? Does this matter?
c. Who buys those century bonds?
d. Why don’t we see more of these?
e. Under what conditions do you expect NSC to redeem those bonds?
- IBM Floating Rate Note:
a. What is different about this issue?
b. What is the rate? What should we compare it with?
c. Why IBM is raising funds?
- Cephalon Convertible notes:
a. How do these work?
b. How can small no-name company issue debt at 2.5% when Coca Cola has to pay 4.25%?
c. How do you participate in the upside?
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Case answers for Tombstones
1. Microsoft Notes:
Microsoft raised $4.75 billion in unsecured notes to help fund the company’s business; namely, it planned to use the capital for “general corporate purposes, which may include funding for working capital, capital expenditures, repurchases of stock and acquisitions.” Despite this offering being only the second in Microsoft’s history and the significant cash held on their balance sheet, they recognized a unique opportunity to take advantage of incredibly low interest rates and strong investor appetite for high-quality debt.
This paper is considered cheap by historical standards due to the perceived quality and credibility of Microsoft, in addition to the low-interest-rate environment in 2010. In September 2010, short-term rates traded near zero and 30-year bonds traded below 4%, this is much lower than September 2006, when the yield curve traded above 5% across most maturities.
The 3-year issue represented $1.0B notes due in 2013 with an annual coupon of 0.875%, paid semi-annually, priced at 99.835% of the principal amount for a YTM of 0.931%; the 5-year issue represented $1.75B notes due in 2015 with an annual coupon of 1.625%, paid semi-annually, priced at 99.561% of the principal amount for a YTM of 1.717%; the 10-year issue represented $1.0B notes due in 2020 with an annual coupon of 3.000%, paid semi-annually, priced at 99.136% of the principal amount for a YTM of 3.101%; the 30-year issue represented $1.0B notes due in 2040 with an annual coupon of 4.500%, paid semi-annually, priced at 98.911% of the principal amount for a YTM of 4.567%.
The yield to maturity is the effective annual rate of return for a bond, which includes measures of returns from coupons, capital gains or losses, and the reinvestment of coupons at the calculated YTM. The YTM calculation utilizes coupons, which represent the amount that the company pays investors in each period, often with an annual or semi-annual frequency. We can compare YTM to the internal rate of return (IRR) because it can be thought of as the rate that equates the price of the bond to the present value of the bond’s cash flows. Microsoft issued four papers for multiple reasons, including a desire to satiate investor appetite for a variety of maturities.
By offering notes at different yields, they were able to serve buyers with varying investment horizons and space out the times at which the large principal payments are due. Since Microsoft issued these notes at such a low rate, we find it unlikely that they will be called or redeemed. It may make sense for them to call or redeem the bonds if they were able to refinance at a lower cost of capital.
2. Coca Cola Enterprise Notes:
Coca Cola Enterprises, looking to take advantage of the low-interest-rate environment following the financial crisis, issued two series of notes. One was a 3-year issue due 2012 with the principal amount of $350m paying an annual coupon of 3.750%, and the other was a 5-year issue due 2015 with a principal amount of $250m paying an annual coupon of 4.250%.
Given this information, we are able to compute the yields to maturities on the 3-year, and 5-year issues are 3.896% and 4.650%, respectively. With regard to the MFST issue stated above, investors priced the Coca Cola issue much less favorably. For comparable duration bonds such as each companies’ 3-year notes, MFST was able to issue much more debt with a lower coupon and have a lower YTM than Coca Cola. MFST issued $1.0bn with a 0.875% annual coupon with a YTM of .931%, whereas Coca Cola’s 3-year issue was $350m with a 3.750% coupon and a YTM of 3.896%.
These differences occurred for a couple of reasons.
First, MFST had a…